Video: Financial Transactions: Types, Overview

This lesson will help you learn exactly what a financial transaction is and how it applies to the accounting industry. You will learn the different types of financial transactions and the way that each one affects balance sheet accounts.

Rebekiah has taught college accounting and has a master's in both management and business.

This lesson will help you learn exactly what a financial transaction is and how it applies to the accounting industry. You will learn the different types of financial transactions and the way that each one affects balance sheet accounts.

Financial Transaction Defined

Think about your activities of the last week. How many of those involved making a purchase? It could be that the purchase was as small as a piece of gum from a candy store or as large as a new house. Did you pay any monthly bills that were due last week, like a car payment or utility bill? If you did any of those things, then you were part of a financial transaction.

What exactly is a financial transaction? In the accounting industry, a financial transaction is one in which there is some sort of activity that changes the value of the assets, liabilities, or owner's equity of an organization. These types of transactions are two-part transactions consisting of a buyer and a seller, and they always involve money in some way. Financial transactions in accounting are recorded in the accounting journal in chronological order.

Types of Financial Transactions

There are four main types of financial transactions that occur in a business. These four types of financial transactions are sales, purchases, receipts, and payments. Let's take a minute to learn about each one:

Sales are the transactions in which property is transferred from buyer to seller for money or credit. Sales transactions are recorded in the accounting journal for the seller as a debit to cash or accounts receivable and a credit to the sales account.

Purchases are the transactions that are required by a business in order to obtain the goods or services needed to accomplish the goals of the organization. Purchases made in cash result in a debit to the inventory account and a credit to cash. If the purchase is made with a credit account, the debit entry would still be to the inventory account and the credit entry would be to the accounts payable account.

Receipts are the transactions that refer to a business getting paid for delivering goods or services to another business. The receipt transaction is recorded in the journal for the seller as a debit to cash and a credit to accounts receivable.

Payments are the transactions that refer to a business receiving money for a good or service. They are recorded in the accounting journal of the business issuing the payment as a credit to cash and a debit to accounts payable.

Example

Now that you know the four types of transactions, let's look at the following scenario:

Ben is a cashier at the local hardware store. Early one afternoon old Mr. Dock comes into the store hunting for a new set of wrenches. Ben helps Mr. Dock locate the wrenches and carries them back to the checkout counter. He rings up the purchase and tells Mr. Dock that his total for the wrenches is $24.73. Mr. Dock writes a check for the exact amount, thanks Ben, and leaves with his purchases.

After Mr. Dock leaves, Ben knows that he must replace the wrenches that he just sold so he calls the tools warehouse and places an order for another set of wrenches. In two days' time a delivery truck brings the wrenches that Ben ordered to the hardware store. Ben signs the delivery receipt and is handed an invoice for the cost of the wrenches by the delivery driver. After the delivery driver leaves, Ben takes the invoice to his office manager so that the bill can be paid. The office manager writes a check for the invoice and mails the payment back to the tools warehouse. The tools warehouse receives the payment and credits.

In this scenario, can you determine what types of transactions have taken place? Here's a little help:

The sales transaction occurred at the time that Ben received payment for the wrenches and then handed them to Mr. Dock. At this point, ownership of the wrenches changed hands. The hardware store had an increase in cash and a decrease in inventory.

The purchase transaction began when Ben placed the order for a new set of wrenches from the tool warehouse and was completed when the he signed for their delivery. Though no money changed hands at the time of delivery, this transaction is considered complete. For purchase transactions, the general rule is that property rights between buyer and seller change hands when the buyer receives the property, not when it's paid for.

The payment transaction occurred when the office manager wrote the check for the invoice and mailed it to the tool warehouse.

The receipt transaction occurred when the tools warehouse received, posted, and deposited the payment from the hardware store.

As you can see, one business event can often trigger several financial transactions. It is a vital and necessary part of the accounting cycle to recognize and record each individual transaction.

Lesson Summary

Financial transactions are events that occur that change the value of an asset, a liability, or an owner's equity. In business, there are four main types of financial transactions, and they include sales, purchases, receipts, and payments. All financial transactions that occur have an effect on at least two accounts, depending on the type of transaction. One account will increase in value, while the second account decreases.

There are times when there are more than two accounts that are affected in a single financial transaction. Those who work in the accounting industry have to learn to recognize what type of transaction each one is and what accounts the transaction affects. By doing so and recording the transactions, a company can generate accurate financial statements.

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